Amidst the market volatility, investors sometimes forget that stocks and bonds fundamentally represent sources of capital for business operations. When capital is plentiful and prices are high, it is cheap for companies to invest in growth to open new stores, spend on marketing, hire employees, and make acquisitions by issuing new equity or cheap debt. Today, higher interest rates and lower stock prices means the opposite. Because capital has become more expensive, companies need to prioritize growth opportunities and become profitable to ensure the sustainability of the business. Unprofitable companies can no longer use their lofty stock prices as employee compensation, leading to layoffs particularly in the technology sector. Even large, profitable companies such as Google have changed their tone on efficiency:
“We want to make sure as a company, when you have fewer resources than before, you are prioritizing all the right things to be working on and your employees are really productive that they can actually have impact on the things they’re working on so that’s what we are spending our time on.”
Sundar Pichai, Alphabet Inc CEO
At Baskin Wealth Management, none the businesses we have purchased in our client portfolios need the capital markets to fund ongoing operations and can fund growth investments and shareholder returns using internal cash flow generation. Profitability, margins, and cash flow generation are important criteria for inclusion in our portfolios, and we expect most companies in our portfolio to report growth in profits despite a potential recession.
Even better however, are companies that can take advantage of capital market conditions to gain market share or create shareholder value. These companies are run by shrewd CEOs that have the introspection to raise capital when it is cheap and plentiful while maintaining a strong balance sheet with the understanding that good times may not last. In uncertain economic times, such companies are well positioned to capitalize on market distress by making attractive M&A or by repurchasing their own stock.
A good example is CCL Industries. CCL Industries is the world’s largest maker of labels, making everything from shampoo bottle labels to drug inserts to polymer banknotes. Under CEO Geoffrey Martin, CCL has a strong track record of opportunistic capital allocation. Two of CCL’s business segments (Avery and Checkpoint) were acquired from highly motivated sellers at attractive prices and are important drivers of CCL’s profitability today.
CCL slowed down its pace of acquisitions during 2020 and 2021 both due to travel restrictions and expensive acquisition prices and used most of its cash flow to reduce debt. By 2022, CCL had a very clean balance sheet and with its stock price falling along with the rest of the market, was able to create value by buying back its own stock.
Analyst: This is the first time you’ve been buying back stock for maybe 10 or 15 years. I’m curious as to the motivation?
Geoffrey Martin: I think the stock is very attractively priced right now, so we’re doing what you expect us to do when the stock is attractively priced (by buying back stock).
This mentality is in contrast to the vast majority of companies such as American Airlines that bought back billions in stock in the years before 2020 and was forced to issue shares at the depths of the pandemic at all-time low share prices.
We expect many of our portfolio companies to benefit from the current weak market environment. Companies like Copart, CoStar Group, Costco, Constellation Software, Microsoft, Blackrock, Waste Connections, Amazon.com, and Canadian Natural Resources (in no particular order) have very strong balance sheets and will be able to make attractive M&A or repurchase stock at cheap prices if the opportunity arises. Others such as TFI International, Brookfield Asset Management and Canadian Apartment Properties REIT are taking advantage of elevated prices in private markets by selling assets at high prices to repurchase shares.
In short, we have no idea when the stock market will rebound but feel confident that the companies in our portfolio will capitalize on current market conditions to create long-term value.
Ernest Wong, Head of Research
